DRI-172 for week of 7-5-15: How and Why Did ObamaCare Become SCOTUSCare?

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How and Why Did ObamaCare Become SCOTUSCare?

On June 25, 2015, the Supreme Court of the United States delivered its most consequential opinion in recent years in King v. Burwell. King was David King, one of various Plaintiffs opposing Sylvia Burwell, Secretary of Health, Education and Welfare. The case might more colloquially be called “ObamaCare II,” since it dealt with the second major attempt to overturn the Obama administration’s signature legislative achievement.

The Obama administration has been bragging about its success in attracting signups for the program. Not surprisingly, it fails to mention two facts that make this apparent victory Pyrrhic. First, most of the signups are people who lost their previous health insurance due to the law’s provisions, not people who lacked insurance to begin with. Second, a large chunk of enrollees are being subsidized by the federal government in the form of a tax credit for the amount of the insurance.

The point at issue in King v. Burwell is the legality of this subsidy. The original legislation provides for health-care exchanges established by state governments, and proponents have been quick to cite these provisions to pooh-pooh the contention that the Patient Protection and Affordable Care Act (PPACA) ushered in a federally-run, socialist system of health care. The specific language used by PPAACA in Section 1401 is that the IRS can provide tax credits for insurance purchased on “exchanges run by the State.” That phrase appears 14 times in Section 1401 and each time it clearly refers to state governments, not the federal government. But in actual practice, states have found it excruciatingly difficult to establish these exchanges and many states have refused to do so. Thus, people in those states have turned to the federal-government website for health insurance and have nevertheless received a tax credit under the IRS’s interpretation of statute 1401. That interpretation has come to light in various lawsuits heard by lower courts, some of which have ruled for plaintiffs and against attempts by the IRS and the Obama administration to award the tax credits.

Without the tax credits, many people on both sides of the political spectrum agree, PPACA will crash and burn. Not enough healthy people will sign up for the insurance to subsidize those with pre-existing medical conditions for whom PPACA is the only source of external funding for medical treatment.

To a figurative roll of drums, the Supreme Court of the United States (SCOTUS) released its opinion on June 25, 2015. It upheld the legality of the IRS interpretation in a 6-3 decision, finding for the government and the Obama administration for the second time. And for the second time, the opinion for the majority was written by Chief Justice John Roberts.

Roberts’ Rules of Constitutional Disorder

Given that Justice Roberts had previously written the opinion upholding the constitutionality of the law, his vote here cannot be considered a complete shock. As before, the shock was in the reasoning he used to reach his conclusion. In the first case (National Federation of Independent Businesses v. Sebelius, 2012), Roberts interpreted a key provision of the law in a way that its supporters had categorically and angrily rejected during the legislative debate prior to enactment and subsequently. He referred to the “individual mandate” that uninsured citizens must purchase health insurance as a tax. This rescued it from the otherwise untenable status of a coercive consumer directive – something not allowed under the Constitution.

Now Justice Roberts addressed the meaning of the phrase “established by the State.” He did not agree with one interpretation previously made by the government’s Solicitor General, that the term was an undefined term of art. He disdained to apply a precedent established by the Court in a previous case involving interpretation of law by administration agencies, the Chevron case. The precedent said that in cases where a phrase was ambiguous, a reasonable interpretation by the agency charged with administering the law would rule. In this case, though, Roberts claimed that since “the IRS…has no expertise in crafting health-insurance policy of this sort,” Congress could not possibly have intended to grant the agency this kind of discretion.

No, Roberts is prepared to believe that “established by the State” does not mean “established by the federal government,” all right. But he says that the Supreme Court cannot interpret the law this way because it will cause the law to fail to achieve its intended purpose. So, the Court must treat the wording as ambiguous and interpret it in such a way as to advance the goals intended by Congress and the administration. Hence, his decision for defendant and against plaintiffs.

In other words, he rejected the ability of the IRS to interpret the meaning of the phrase “established by the State” because of that agency’s lack of health-care-policy expertise, but is sufficiently confident of his own expertise in that area to interpret its meaning himself; it is his assessment of the market consequences that drives his decision to uphold the tax credits.

Roberts’ opinion prompted one of the most scathing, incredulous dissents in the history of the Court, by Justice Antonin Scalia. “This case requires us to decide whether someone who buys insurance on an exchange established by the Secretary gets tax credits,” begins Scalia. “You would think the answer would be obvious – so obvious that there would hardly be a need for the Supreme Court to hear a case about it… Under all the usual rules of interpretation… the government should lose this case. But normal rules of interpretation seem always to yield to the overriding principle of the present Court – the Affordable Care Act must be saved.”

The reader can sense Scalia’s mounting indignation and disbelief. “The Court interprets [Section 1401] to award tax credits on both federal and state exchanges. It accepts that the most natural sense of the phrase ‘an exchange established by the State’ is an exchange established by a state. (Understatement, thy name is an opinion on the Affordable Care Act!) Yet the opinion continues, with no semblance of shame, that ‘it is also possible that the phrase refers to all exchanges.’ (Impossible possibility, thy name is an opinion on the Affordable Care Act!)”

“Perhaps sensing the dismal failure of its efforts to show that ‘established by the State’ means ‘established by the State and the federal government,’ the Court tries to palm off the pertinent statutory phrase as ‘inartful drafting.’ The Court, however, has no free-floating power to rescue Congress from their drafting errors.” In other words, Justice Roberts has rewritten the law to suit himself.

To reinforce his conclusion, Scalia concludes with “…the Court forgets that ours is a government of laws and not of men. That means we are governed by the terms of our laws and not by the unenacted will of our lawmakers. If Congress enacted into law something different from what it intended, then it should amend to law to conform to its intent. In the meantime, Congress has no roving license …to disregard clear language on the view that … ‘Congress must have intended’ something broader.”

“Rather than rewriting the law under the pretense of interpreting it, the Court should have left it to Congress to decide what to do… [the] Court’s two cases on the law will be remembered through the years. And the cases will publish the discouraging truth that the Supreme Court favors some laws over others and is prepared to do whatever it takes to uphold and assist its favorites… We should start calling this law SCOTUSCare.”

Jonathan Adler of the much-respected and quoted law blog Volokh Conspiracy put it this way: “The umpire has decided that it’s okay to pinch-hit to ensure that the right team wins.”

And indeed, what most stands out about Roberts’ opinion is its contravention of ordinary constitutional thought. It is not the product of a mind that began at square one and worked its way methodically to a logical conclusion. The reader senses a reversal of procedure; the Chief Justice started out with a desired conclusion and worked backwards to figure out how to justify reaching it. Justice Scalia says as much in his dissent. But Scalia does not tell us why Roberts is behaving in this manner.

If we are honest with ourselves, we must admit that we do not know why Roberts is saying what he is saying. Beyond question, it is arbitrary and indefensible. Certainly it is inconsistent with his past decisions. There are various reasons why a man might do this.

One obvious motivation might be that Roberts is being blackmailed by political supporters of the PPACA, within or outside of the Obama administration. Since blackmail is not only a crime but also a distasteful allegation to make, nobody will advance it without concrete supporting evidence – not only evidence against the blackmailer but also an indication of his or her ammunition. The opposite side of the blackmail coin is bribery. Once again, nobody will allege this publicly without concrete evidence, such as letters, tapes, e-mails, bank account or bank-transfer information. These possibilities deserve mention because they lie at the head of a short list of motives for betrayal of deeply held principles.

Since nobody has come forward with evidence of malfeasance – or is likely to – suppose we disregard that category of possibility. What else could explain Roberts’ actions? (Note the plural; this is the second time he has sustained PPACA at the cost of his own integrity.)

Lord Acton Revisited

To explain John Roberts’ actions, we must develop a model of political economy. That requires a short side trip into the realm of political philosophy.

Lord Acton’s famous maxim is: “Power corrupts; absolute power corrupts absolutely.” We are used to thinking of it in the context of a dictatorship or of an individual or institution temporarily or unjustly wielding power. But it is highly applicable within the context of today’s welfare-state democracies.

All of the Western industrialized nations have evolved into what F. A. Hayek called “absolute democracies.” They are democratic because popular vote determines the composition of representative governments. But they are absolute in scope and degree because the administrative agencies staffing those governments are answerable to no voter. And increasingly the executive, legislative and judicial branches of the governments wield powers that are virtually unlimited. In practical effect, voters vote on which party will wield nominal executive control over the agencies and dominate the legislature. Instead of a single dictator, voters elect a government body with revolving and rotating dictatorial powers.

As the power of government has grown, the power at stake in elections has grown commensurately. This explains the burgeoning amounts of money spent on elections. It also explains the growing rancor between opposing parties, since ordinary citizens perceive the loss of electoral dominance to be subjugation akin to living under a dictatorship. But instead of viewing this phenomenon from the perspective of John Q. Public, view it from within the brain of a policymaker or decisionmaker.

For example, suppose you are a completely fictional Chairman of a completely hypothetical Federal Reserve Board. We will call you “Bernanke.” During a long period of absurdly low interest rates, a huge speculative boom has produced unprecedented levels of real-estate investment by banks and near-banks. After stoutly insisting for years on the benign nature of this activity, you suddenly perceive the likelihood that this speculative boom will go bust and some indeterminate number of these financial institutions will become insolvent. What do you do? 

Actually, the question is really more “What do you say?” The actions of the Federal Reserve in regulating banks, including those threatened with or undergoing insolvency, are theoretically set down on paper, not conjured up extemporaneously by the Fed Chairman every time a crisis looms. These days, though, the duties of a Fed Chairman involve verbal reassurance and massage as much as policy implementation. Placing those duties in their proper light requires that our side trip be interrupted with a historical flashback.

Let us cast our minds back to 1929 and the onset of the Great Depression in the United States. At that time, virtually nobody foresaw the coming of the Depression – nobody in authority, that is. For many decades afterwards, the conventional narrative was that President Herbert Hoover adopted a laissez faire economic policy, stubbornly waiting for the economy to recover rather than quickly ramping up government spending in response to the collapse of the private sector. Hoover’s name became synonymous with government passivity in the face of adversity. Makeshift shanties and villages of the homeless and dispossessed became known as “Hoovervilles.”

It took many years to dispel this myth. The first truthteller was economist Murray Rothbard in his 1962 book America’s Great Depression, who pointed out that Hoover had spent his entire term in a frenzy of activism. Far from remaining a pillar of fiscal rectitude, Hoover had presided over federal deficit spending so large that his successor, Democrat Franklin Delano Roosevelt, campaigned on a platform of balancing the federal-government budget. Hoover sternly warned corporate executives not to lower wages and officially adopted an official stance in favor of inflation.

Professional economists ignored Rothbard’s book in droves, as did reviewers throughout the mass media. Apparently the fact that Hoover’s policies failed to achieve their intended effects persuaded everybody that he couldn’t have actually followed the policies he did – since his actual policies were the very policies recommended by mainstream economists to counteract the effects of recession and Depression and were largely indistinguishable in kind, if not in degree, from those followed later by Roosevelt.

The anathematization of Herbert Hoover drover Hoover himself to distraction. The former President lived another thirty years, to age ninety, stoutly maintaining his innocence of the crime of insensitivity to the misery of the poor and unemployed. Prior to his presidency, Hoover had built reputation as one of the great humanitarians of the 20th century by deploying his engineering and organizational skills in the cause of disaster relief across the globe. The trashing of his reputation as President is one of history’s towering ironies. As it happened, his economic policies were disastrous, but not because he didn’t care about the people. His failure was ignorance of economics – the same sin committed by his critics.

Worse than the effects of his policies, though, was the effect his demonization has had on subsequent policymakers. We do not remember the name of the captain of the California, the ship that lay anchored within sight of the Titanic but failed to answer distress calls and go to the rescue. But the name of Hoover is still synonymous with inaction and defeat. In politics, the unforgivable sin became not to act in the face of any crisis, regardless of the consequences.

Today, unlike in Hoover’s day, the Chairman of the Federal Reserve Board is the quarterback of economic policy. This is so despite the Fed’s ambiguous status as a quasi-government body, owned by its member banks with a leader appointed by the President. Returning to our hypothetical, we ponder the dilemma faced by the Chairman, “Bernanke.”

Bernanke only directly controls monetary policy and bank regulation. But he receives information about every aspect of the U.S. economy in order to formulate Fed policy. The Fed also issues forecasts and recommendations for fiscal and regulatory policies. Even though the Federal Reserve is nominally independent of politics and from the Treasury department of the federal government, the Fed’s policies affect and are affected by government policies.

It might be tempting to assume that Fed Chairmen know what is going to happen in the economic future. But there is no reason to believe that is true. All we need do is examine their past statements to disabuse ourselves of that notion. Perhaps the popping of the speculative bubble that Bernanke now anticipates will produce an economic recession. Perhaps it will even topple the U.S. banking system like a row of dominoes and produce another Great Depression, a la 1929. But we cannot assume that either. The fact that we had one (1) Great Depression is no guarantee that we will have another one. After all, we have had 36 other recessions that did not turn into Great Depressions. There is nothing like a general consensus on what caused the Depression of the 1920s and 30s. (The reader is invited to peruse the many volumes written by historians, economic and non-, on the subject.) About the only point of agreement among commentators is that a large number of things went wrong more or less simultaneously and all of them contributed in varying degrees to the magnitude of the Depression.

Of course, a good case might be made that it doesn’t matter whether Fed Chairman can foresee a coming Great Depression or not. Until recently, one of the few things that united contemporary commentators was their conviction that another Great Depression was impossible. The safeguards put in place in response to the first one had foreclosed that possibility. First, “automatic stabilizers” would cause government spending to rise in response to any downturn in private-sector spending, thereby heading off any cumulative downward movement in investment and consumption in response to failures in the banking sector. Second, the Federal Reserve could and would act quickly in response to bank failures to prevent the resulting reverse-multiplier effect on the money supply, thereby heading off that threat at the pass. Third, bank regulations were modified and tightened to prevent failures from occurring or restrict them to isolated cases.

Yet despite everything written above, we can predict confidently that our fictional “Bernanke” would respond to a hypothetical crisis exactly as the real Ben Bernanke did respond to the crisis he faced and later described in the book he wrote about it. The actual and predicted responses are the same: Scare the daylights out of the public by predicting an imminent Depression of cataclysmic proportions and calling for massive government spending and regulation to counteract it. Of course, the real-life Bernanke claimed that he and Treasury Secretary Henry O’Neill correctly foresaw the economic future and were heroically calling for preventive measures before it was too late. But the logic we have carefully developed suggests otherwise.

Nobody – not Federal Reserve Chairmen or Treasury Secretaries or California psychics – can foresee Great Depressions. Predicting a recession is only possible if the cyclical process underlying it is correctly understood, and there is no generally accepted theory of the business cycle. No, Bernanke and O’Neill were not protecting America with their warning; they were protecting themselves. They didn’t know that a Great Depression was in the works – but they did know that they would be blamed for anything bad that did happen to the economy. Their only way of insuring against that outcome – of buying insurance against the loss of their jobs, their professional reputations and the possibility of historical “Hooverization” – was to scream for the biggest possible government action as soon as possible. 

Ben Bernanke had been blasé about the effects of ultra-low interest rates; he had pooh-poohed the possibility that the housing boom was a bubble that would burst like a sonic boom with reverberations that would flatten the economy. Suddenly he was confronted with a possibility that threatened to make him look like a fool. Was he icy cool, detached, above all personal considerations? Thinking only about banking regulations, national-income multipliers and the money supply? Or was he thinking the same thought that would occur to any normal human being in his place: “Oh, my God, my name will go down in history as the Herbert Hoover of Fed chairmen”?

Since the reasoning he claims as his inspiration is so obviously bogus, it is logical to classify his motives as personal rather than professional. He was protecting himself, not saving the country. And that brings us to the case of Chief Justice John Roberts.

Chief Justice John Roberts: Selfless, Self-Interested or Self-Preservationist?

For centuries, economists have identified self-interest as the driving force behind human behavior. This has exasperated and even angered outside observers, who have mistaken self-interest for greed or money-obsession. It is neither. Rather, it merely recognizes that the structure of the human mind gives each of us a comparative advantage in the promotion of our own welfare above that of others. Because I know more about me than you do, I can make myself happier than you can; because you know more about you than I do, you can make yourself happier than I can. And by cooperating to share our knowledge with each other, we can make each other happier through trade than we could be if we acted in isolation – but that cooperation must preserve the principle of self-interest in order to operate efficiently.

Strangely, economists long assumed that the same people who function well under the guidance of self-interest throw that principle to the winds when they take up the mantle of government. Government officials and representatives, according to traditional economics textbooks, become selfless instead of self-interested when they take office. Selflessness demands that they put the public welfare ahead of any personal considerations. And just what is the “public welfare,” exactly? Textbooks avoided grappling with this murky question by hiding behind notions like a “social welfare function” or a “community indifference curve.” These are examples of what the late F. A. Hayek called “the pretense of knowledge.”

Beginning in the 1950s, the “public choice” school of economics and political science was founded by James Buchanan and Gordon Tullock. This school of thought treated people in government just like people outside of government. It assumed that politicians, government bureaucrats and agency employees were trying to maximize their utility and operating under the principle of self-interest. Because the incentives they faced were radically different than those faced by those in the private sector, outcomes within government differed radically from those outside of government – usually for the worse.

If we apply this reasoning to members of the Supreme Court, we are confronted by a special kind of self-interest exercised by people in a unique position of power and authority. Members of the Court have climbed their career ladder to the top; in law, there are no higher rungs. This has special economic significance.

When economists speak of “competition” among input-suppliers, we normally speak of people competing with others doing the same job for promotion, raises and advancement. None of these are possible in this context. What about more elevated kinds of recognition? Well, there is certainly scope for that, but only for the best of the best. On the current court, positive recognition goes to those who write notable opinions. Only Judge Scalia has the special talent necessary to stand out as a legal scholar for the ages. In this sense, Judge Scalia is “competing” with other judges in a self-interested way when he writes his decisions, but he is not competing with his fellow judges. He is competing with the great judges of history – John Marshall, Oliver Wendell Holmes, Louis Brandeis, and Learned Hand – against whom his work is measured. Otherwise, a judge can stand out from the herd by providing the deciding or “swing” vote in close decisions. In other words, he can become politically popular or unpopular with groups that agree or disagree with his vote. Usually, that results in transitory notoriety.

But in historic cases, there is the possibility that it might lead to “Hooverization.”

The bigger government gets, the more power it wields. More government power leads to more disagreement about its role, which leads to more demand to arbitration by the Supreme Court. This puts the Court in the position of deciding the legality of enactments that claim to do great things for people while putting their freedoms and livelihoods in jeopardy. Any judge who casts a deciding vote against such a measure will go down in history as “the man who shot down” the Great Bailout/the Great Health Care/the Great Stimulus/the Great Reproductive Choice, ad infinitum.

Almost all Supreme Court justices have little to gain but a lot to lose from opposing a measure that promotes government power. They have little to gain because they cannot advance further or make more money and they do not compete with J. Marshall, Holmes, Brandeis or Hand. They have a lot to lose because they fear being anathematized by history, snubbed by colleagues, picketed or assassinated in the present day, and seeing their children brutalized by classmates or the news media. True, they might get satisfaction from adhering to the Constitution and their personal conception of justice – if they are sheltered under the umbrella of another justice’s opinion or they can fly under the radar of media scrutiny in a relatively low-profile case.

Let us attach a name to the status occupied by most Supreme Court justices and to the spirit that animates them. It is neither self-interest nor selflessness in their purest forms; we shall call it self-preservation. They want to preserve the exalted status they enjoy and they are not willing to risk it; they are willing to obey the Constitution, observe the law and speak the truth but only if and when they can preserve their position by doing so. When they are threatened, their principles and convictions suddenly go out the window and they will say and do whatever it takes to preserve what they perceive as their “self.” That “self” is the collection of real income, perks, immunities and prestige that go with the status of Supreme Court Justice.

Supreme Court Justice John Roberts is an example of the model of self-preservation. In both of the ObamaCare decisions, his opinions for the majority completely abdicated his previous conservative positions. They plumbed new depths of logical absurdity – legal absurdity in the first decision and semantic absurdity in the second one. Yet one day after the release of King v. Burwell, Justice Roberts dissented in the Obergefell case by chiding the majority for “converting personal preferences into constitutional law” and disregarding clear meaning of language in the laws being considered. In other words, he condemned precisely those sins he had himself committed the previous day in his majority opinion in King v. Burwell.

For decades, conservatives have watched in amazement, scratching their heads and wracking their brains as ostensibly conservative justices appointed by Republican presidents unexpectedly betrayed their principles when the chips were down, in high-profile cases. The economic model developed here lays out a systematic explanation for those previously inexplicable defections. David Souter, Anthony Kennedy, John Paul Stevens and Sandra Day O’Connor were the precursors to John Roberts. These were not random cases. They were the systematic workings of the self-preservationist principle in action.

DRI-303 for week of 5-11-14: The Real ‘Stress Test’ is Still to Come

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The Real ‘Stress Test’ is Still to Come

Timothy Geithner, former Treasury Secretary and former head of the New York Federal Reserve, is in the news. Like virtually every former policymaker, he has written a book about his experiences. He is currently flogging that book on the publicity circuit. Unlike many other such books, Geithner’s holds uncommon interest – not because he is a skillful writer or a keen analyst. Just the opposite.

Geithner is a man desperate to rationalize his past actions. Those actions have put us on a path to disaster. When that disaster strikes, we will be too stunned and too busy to think clearly about the past. Now is the time to view history coolly and rationally. We must see Geithner’s statements in their true light.

Power and the Need for Self-Justification

In his Wall Street Journal book review of Geithner’s book, Stress Test, James Freeman states that “Geithner makes a persuasive case that he is the man most responsible for the federal bailouts of 2008.” Mr. Freeman finds this claim surprising, but as we will see, it is integral to what Geithner sees as his legacy.

This issue of policy authorship is important to historians, whose job is getting the details right. But it is trivial to us. We want the policies to be right, regardless of their source. That is why we should be worried by Geithner’s need to secure his place in history.

Geithner and his colleagues, Federal Reserve Chairman Ben Bernanke and then-Treasury Secretary Henry Paulson, possessed powers whose exercise would have been unthinkable not that long ago. Nobody seems to have considered how the possession of such vast powers would distort their exercise.

Prior to assumption of the Federal Reserve Chairmanship, Ben Bernanke wrote his dissertation on the causes of the Great Depression. Later, his academic reputation was built on his assessment of mistakes committed by Fed Board members during the 1920s and 30s. When he joined the Board and became Chairman, he vowed not to repeat those mistakes. Thus, we should not have been surprised when he treated a financial crisis on his watch as though it were another Great Depression in the making. Bernanke was the living embodiment of the old saying, “Give a small boy a hammer and he will find that everything he encounters needs pounding.” His academic training had given him a hammer and he proceeded to use it to pound the first crisis he met.

In an interview with “Bloomberg News,” Geithner used the phrase “Great Depression” three times. First, he likened the financial crisis of 2008 to the Great Depression, calling it “classic” and comparing it to the bank runs of the Great Depression. Later, he claimed that we had avoided another Great Depression by following his policies. For Geithner, the Great Depression isn’t so much an actual historical episode or an analytical benchmark as it is an emotional button he presses whenever he needs justification for his actions.

When we give vast power to individuals, we virtually guarantee that they will view events through the lens of their own ego rather than objectively. Bernanke was bound to view his decisions in this light: either apply principles he himself had espoused and built his career upon or run the risk of going down in history as exactly the kind of man he had made his name criticizing – the man who stood by and allowed the Great Depression to happen. Faced with those alternatives, policy activism was the inevitable choice.

Geithner had tremendous power in his advisory capacity as President of the New York Federal Reserve. His choices were: use it or not. Not using it ran the risk of being Hooverized by future generations; that is, being labeled as unwitting, uncaring or worse. Using it at least showed that he cared, even if he failed. The only people who would criticize him would be some far-out, laissez-faire types. Thus, he had everything to gain and little to lose by advising policy activism.

Now, after the fact, the incentive to seek the truth is even weaker than it is in the moment. Now Bernanke, Geithner et al are stuck with their decisions. They cannot change their actions, but they can change anything else – their motivations, those of others, even the truths of history and analysis. If they can achieve by lying or dissembling what they could not achieve with their actions at the time, then dishonesty is a small price to pay. Being honest with yourself can be difficult under the best of circumstances. When somebody is on the borderline between being considered the nation’s savior and its scourge, it is well-nigh impossible.

And a person who begins by lying to himself cannot end up being truthful with the world. No, memoirs like Stress Test are not the place to look for a documentary account of the financial crisis told by an insider. The pressures of power do not shape men like Paulson, Bernanke and Geithner into diamonds, but rather into gargoyles.

We cannot take their words at face value. We must put them under the fluoroscope.

“We Were Three Days Away From Americans Not Being Able to Get Money from ATMs”

Not only are Geithner’s actions under scrutiny, but his timing is also criticized. Many people, perhaps most prominently David Stockman, have insisted that the actual situation faced by the U.S. economy wasn’t nearly dire enough to justify the drastic actions urged by Geithner, et al.

Geithner’s stock reply, found in his book and repeated in numerous interviews, is that the emergency facing the nation left no time for observance of legal niceties or economic precedent. He resuscitates the old quote: “We were three days away from Americans not being able to get money from their ATMs.”

There is an effective reply because its psychological shock value tends to stun the listener into submission. But meek silence is the wrong posture with which to receive a response like this from a self-interested party like Paulson, Bernanke or Geithner. Instead, it demands minute examination.

First, ask ourselves this: Is this a figure of speech or literal truth? That is, what precise significance attaches to the words “three days?”

Recall that Bernanke and Paulson have told us that they realized the magnitude of the emergency facing the country and determined that they must (a) violate protocol by going directly to Congress; and (b) act in secret to prevent public panic. Remember also that Paulson told Congress that if they did not pass bailout legislation by the weekend, Armageddon would ensue. And remember also that, typically, Congress did not act within the deadline specified. It waited  ten days before passing the bailout deal. And the prophesied disaster did not unfold.

In other words, Paulson, Bernanke, et al were exaggerating for effect. How much they were exaggerating can be debated.

That leads to the next logical point. What about the ATM reference itself? Was it specific, meaningful? Or was it just hooey? To paraphrase the line used in courtroom interrogation by litigators (“Are you lying now or were you lying then?”), is Geithner exaggerating now just as Paulson and Bernanke exaggerated then?

Well, Geithner is apparently serious in using this reference. In the same interviews, Geithner calls the financial crisis “a classic financial panic, similar to the bank runs in the Great Depression.” In the 1930s, U.S. banks faced “runs” by depositors who withdrew deposits in cash when they questioned the solvency of banks. Under fractional-reserve banking, banks then (as now) kept only a tiny ratio of deposit liabilities on hand in the form of cash and liquid assets. The runs produced a rash of bank failures, leading to widespread closures and the eventual “bank holiday” proclaimed by newly elected President Franklin Delano Roosevelt. So Geithner’s borrowing of the ATM comment as an index of our distress seems to be clearly intended to suggest an impending crisis of bank liquidity.

There is an obvious problem with this interpretation, the problem being that it is obvious nonsense. Virtually every commentator and reviewer has treated Geithner’s backwards predictions of a “Great Depression” with some throat-clearing version of “well, as we all know, we can’t know what would have happened, we’ll never know, we can’t replay history, history only happens once,” and so forth. But that clearly doesn’t apply to the ATM case. We know – as incontrovertibly as we can know anything in life – what would have happened had bank runs and bank illiquidity a la 1930s so much as threatened in 2008.

Somebody would have stepped to a computer at the Federal Reserve and started creating money. We know this because that’s exactly what did happen in 2010 when the Fed initiated its “Quantitative Easing” program of monetary increase. The overwhelming bulk of the QE money found its way to bank reserve accounts at the Fed where it has been quietly drawing interest ever since. We also know that the usual formalities and intermediaries involving money creation by the Fed could and would have been dispensed with in that sort of emergency. As Fed Chairman, Ben Bernanke was known as “Helicopter Ben” because he was fond of quoting Milton Friedman’s remark that the Fed could get money in public hands by dropping it from helicopters in an emergency, if necessary. Bernanke would not have stood on ceremony in the case of a general bank run; he would have funneled money directly to banks by the speediest means.

In other words, the ATM comment was and is the purest hooey. It has no substantive significance or meaning. It was made, and revived by Geithner, for shock effect only. This is very revealing. It implies a man desperate to achieve his effect, which means his words should be received with utmost caution.

“The Paradox of Financial Crises”

Geithner’s flagship appearance on the promotion circuit was his op-ed in The Wall Street Journal (5/13/2014), “The Paradox of Financial Crises.” The thesis of this op-ed – the “paradox” of the title – is that “the more aggressive the government is in designing a rescue plan, the easier it is to force more restructuring in the financial sector, and the better the chances of leaving the surviving system stronger and less dependent on the taxpayer.” Alas, Geithner complains, “Americans don’t give their presidents much in the way of emergency authority to fight” financial crises. As evidence of the need for this emergency authority, Geithner cites the loss of 16% of U.S. household net worth in 2008, “several times as large as the losses at the start of the Great Depression.”

No doubt eyebrows were raised throughout the U.S. when Geithner bemoaned the lack of emergency authority for a President who has appointed dozens of economic and regulatory “czars,” single-handedly suspended execution of legislation and generally behaved high-handedly. Geithner’s thesis – a generous description of what might reasonably be called a desperate attempt at self-justification – apparently consists of three components: (1) the presumption that financial crises are uniquely powerful and destructive; (2) the claim that, nevertheless, a financial crisis can be counteracted by sufficiently forceful action, taken with sufficient dispatch; and (3) the further claim that he knows what actions to take.

The power of financial crises is a trendy idea given currency by a popular scholarly work by two economists named Rogoff and Reinhart, who surveyed recessions featuring financial panics going back several centuries and ostensibly discovered that their recoveries tended to be slow. How much merit their ideas have is really irrelevant to Geithner’s thesis because Geithner’s interest in financial crises is entirely opportunistic. It began in 2008 with Geithner’s improvisations when faced with the impending failure of Bear Stearns, Lehman Brothers, et al. It perseveres only because Geithner’s legacy is now tied to the success of those machinations – which, unlikely as it might have seemed six years ago, is still in dispute.

Geithner’s theory of financial crises is not the Rogoff/Reinhart theory. It is the Geithner theory, which is: financial crises are uniquely powerful because Geithner needs them to be uniquely powerful in order to justify his unprecedented recommendations for unilateral executive actions. In his book and interviews, Geithner peddles various vague, vacuous generalities about financial crises. In order to these to make sense, they must be based on historical observation and/or statistical regularities. But they cannot jibe with the sentiments expressed above in the Journal. Geithner claims to be enunciating a general theory of financial crisis and rescue. But he is really telling a story of what he did to this particular financial system in the particular financial crisis of 2008.

And no wonder, since the financial system existing in the U.S. in 2008 was and still is like no financial system that existed previously. Instead of “banks” as we previously knew them, the failing financial institutions in 2008 were diversified financial institutions – nominally investment banks, although that activity had by then assumed a minor part of their work – some of whose liabilities would once have been called “near monies.” Meanwhile, the true banks were also diversified into securities and investment banking, and the larger ones controlled the overwhelming bulk of deposit liabilities in the U.S. This historically unprecedented configuration accounted for the determination of Paulson, Bernanke, and Geithner to bail them out at all costs. But they weren’t drawing upon a general theory of crises, because no previous society ever had a financial structure like ours.

Geithner stresses the need to “force more restructuring in the financial sector,” as though every financial crisis was caused by corporate elephantiasis and cured by astute government pruning back of financial firms. This is not only historically wrong but logically deficient, since the past government pruning couldn’t have been very astute if crises kept recurring. Indeed, that is the obvious shortcoming of the second component. There are no precedents – none, zero, nada – for the idea that government policy can either forestall or cure recessions, whether financial or otherwise. This is not for want of trying. If there is one thing governments love to do, it is spend money. If there is another thing governments love to do, it is throw their weight around. Neither has solved the problem of recession so far.

What leads us to believe that Timothy Geithner was and is well qualified to pronounce on the subject of financial crises? Only one thing – his claims that “we did do the essential thing, which was to prevent another Great Depression, with its decade of shantytowns and bread lines. We put out the financial fire…because we wanted to prevent mass unemployment.”

Incredible as it seems now, Timothy Geithner had even fewer economic credentials for his post as Chairman of the New York Federal Reserve than Ben Bernanke had for his as Chairman of the Federal Reserve Board of Governors. Geithner had only one economics course as a Dartmouth undergraduate (he found it “dreary”). His master’s degree at John’s Hopkins was split between international economics and Far Eastern studies. (He speaks Japanese, among other foreign languages.) He put in a three-year stint as a consultant with Henry Kissinger’s consulting firm before graduating to the Treasury, where he spent 13 years before moving to the International Monetary Fund, then becoming Chairman of the New York Fed at age 42. As Freeman observed in his book review, Geithner “never worked in finance or in any type of business” save Kissinger’s consulting firm.

This isn’t exactly a resume of recommendation for a man taking the tiller during a financial typhoon. Maybe it explains what Freeman called Geithner’s “difficulty in understanding the health of large financial firms.”

When asked by interviewers if he had any regrets about his tenure, Geithner regrets not foreseeing the crisis in time to act sooner. This certainly contradicts his theory of crises and his claim of special knowledge – if he was the man with a plan and the man of the moment, why did he fail to foresee the crisis and have to go begging for emergency authorization for Presidential action at the 11th hour? Why should we now eagerly devour the words of a man who claims responsibility for saving the nation while simultaneously admitting that he “didn’t see the crisis coming and didn’t grasp the severity of the problems when it appeared?” He now boasts a special understanding of financial crises, but “didn’t require the banks he was overseeing to raise more capital” at the time of the crisis. In fact, as Freeman discloses, the minutes of the Federal Reserve show that Geithner denies that the banking system in general was undercapitalized even while other Fed governors were proposing that banks meet a capital call.

Geithner offers no particular reason why we should believe anything he says and ample reasons for doubt.

“The Government and the Central Bank Have to Step In and Take Risks”

Geithner’s book and publicity tour are a public-relations exercise designed to change his image. Ironically, this involves a tradeoff. He had image problems with both the right wing and the left wing, so gains on one side rate to lose him support on the other side. The Wall Street Journal piece shows that he wants to burnish his left profile. He closes by lamenting that “we were not able to do all that was important or desirable.  …Long-term unemployment remains alarmingly high. There are very high levels of poverty and appalling inequality, not just in income and wealth, but in the opportunities Americans have for a quality education or economic mobility.” Having spent the bulk of the op-ed apologizing for not allowing undeserving Wall Street bankers to go broke, he now nods frantically to every left-wing preoccupation. None of this has anything to do with a financial crisis or emergency authorizations or stress tests, of course – it is just Geithner stroking his left-wing critics.

The real sign that Geithner’s allegiance is with the left is his renunciation of the concept of “moral hazard.” Oh, he gives lip service to the fact that when the government bails out business and subsidizes failure, this will encourage subsequent businessmen to take excessive risks on a “heads I win, tails the government bails me out” expectation. But he savagely criticizes the moral hazard approach as “Old Testament” thinking. (The fact that “Old Testament” is now a pejorative is significant in itself; one wonders what significance “New Testament” would have.) “What one has to do in a panic is the opposite of what seems fair and just. In a financial crisis, the natural instinct is to let creditors suffer losses, let firms fail, and protect taxpayers from any risk of loss. But in a financial panic, a strategy based on those instincts will lead to depression-level unemployment. Instead, the government and the central bank have to step in and take risks on a scale that the private sector can’t and won’t… reduce the incentive for investors, lenders and depositors to run…raise the confidence of businesses and individuals… breaking a vicious cycle in which the fear of a financial-system collapse and a deep recession feed on each other and become self-fulfilling.”

This is surely the clearest sign that Geithner is engaging in ex post rationalization and improvisation. For centuries, economists have debated the question of whether recessions are real or monetary in origin and substance. Now Geithner emerges with the secret: they are psychological. Keynes, it seems, was the second-most momentous thinker of the 1930s, behind Sigmund Freud. All we have to do is overcome our “natural instinct” and rid ourselves of those awful “Old Testament” morals and bail out the right people – creditors – instead of the wrong people – taxpayers.

Once again, commentators have glossed over the most striking contradictions in this tale. For five years, we have listened ad nauseum to scathing denunciations of bankers, real-estate brokers, developers, investment bankers, house flippers and plain old home buyers who went wild and crazy, taking risks right and left with reckless abandon. But now Geithner is telling us that the problem is that “the private sector can’t and won’t …take risks on a scale” sufficient to save us from depression! So government and the central bank (!) must gird their loins, step in and do the job.

But this is a tale left unfinished.  Geithner says plainly that his actions saved us from a Great Depression. He also says that salvation occurred because government and the Fed assumed risks on a massive scale. What happened to those risks? Did they vanish somewhere in a puff of smoke or cloud of dust? If not, they must still be borne. And if the risks are still active, that means that we have not, after all, been saved from the Great Depression; it has merely been postponed.

It is not too hard to figure out what Geithner is saying between the lines. He wants to justify massive Federal Reserve purchases of toxic bank assets and the greatest splurge of money creation in U.S. history – without having to mention that these put us all on a hook where we remain to this day.

In this sense, Timothy Geithner’s book was well titled. Unfortunately, he omitted to mention that the most stressful test is yet to come.

DRI-201 for week of 1-12-14: No Bravos for Bernanke

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No Bravos for Bernanke

Last weekend’s Wall Street Journal featured an op-ed by the former Chairman of President Obama’s Council of Economic Advisors, Austan Goolsbee. Goolsbee’s tenure obviously familiarized him with the chief requirement for policymaking success in a Democrat regime; namely, the ability to define success down. His op-ed, “Brave for Bernanke and the QE Era,” is a spectacular example of the art.

Goolsbee contrasts the enthusiastic reception given to Federal Reserve Chairman Bernanke’s farewell address to the American Economic Association convention with the wide-ranging criticism directed at Bernanke from across the political spectrum. He briefly summarizes the Fed’s policies under Bernanke, confining himself to the last 3 ½ years of the so-called QE (quantitative easing) Era. Bernanke’s imminent departure and the start of the “exit-strategy countdown” signaled by QE tapering mean that “it is time to take stock of the QE Era – and time for the critics to admit they were wrong.”

Partisan divisions being what they are, it is a foregone conclusion that Goolsbee’s call will not resonate with many on both sides of the political spectrum. But it is not necessary to invoke partisan politics to criticize it. Bernanke’s policies – and Goolsbee’s – are anathema to free-market economists. But one need not espouse laissez faire in order to gaze askance at Goolsbee’s case for Bernanke’s actions. Bernanke’s tenure should be viewed as a disaster regardless of one’s political preference or economic philosophy.

Indeed, the propriety of Bernanke’s policy choices is not up for debate at this point. They are what economists would call a sunk cost; their costs have been incurred (or are unavoidable) and can’t be changed or escaped. No doubt Bernanke should have chosen differently and we would be better off if he had done so. But the question before the house is: What were the actual results of his choices? Goolsbee finds those results to be very good and purports to explain why. We can and should quarrel with his verdict and his explanations.

Bernanke and Stimulus

“…Looking back…it is clear that the Fed was right to try to help improve the [economy] and the critics were wrong [about inflation].” Goolsbee assigns Bernanke’s policies a grade of A for activism.  The implication is that it is better for a Federal Reserve Chairman to do something rather than nothing, even if activism requires a program of unprecedented scope and unknown impact.

“Think back to the days before the 2008 crisis or recession. If confronted with the scenario that would follow – five years of GDP growth of only around 2% a year, five years of unemployment rates around or above 7%, core inflation consistently below 2% – the near-universal response of economists would have been for the Fed to cut interest rates.” But would economists have reacted that way knowing that all of these effects accompanied a policy of zero interest rates? It’s one thing to say “we should have cut interest rates and all these bad things wouldn’t have happened,” but quite another to say “all these bad things happened anyway in spite of our interest rate cuts.” An objective observer would have to consider the possibility that the interest rate cuts were the wrong medicine. Of course, Goolsbee pretends that this is unthinkable; that the only possible action in the face of adversity is cutting rates. But if that were really true, his review of Bernanke’s reign is a mere formality; Bernanke’s decisions were right by definition, regardless of result. In reality, of course, the zero-interest-rate policy was not a foregone conclusion but rather an evaluative action subject to serious question. And its results do not constitute a ringing endorsement.

To appreciate the truth of this, ponder the wildly varying conclusions reached by Keynesian economists who are not ideologically hostile to Bernanke and Goolsbee. Larry Summers considers macroeconomic policy under Obama a failure because the U.S. suffers from “secular stagnation.” He prescribes a cure of massive public spending to replace the structural collapse of private investment and private over-saving. While Bernanke cannot take the blame for the failings of fiscal policy, Summers criticizes him for not doing more to provide liquidity and increase (!) inflation. Summers’ colleague Paul Krugman is even more emphatic. Bernanke should crank up the printing press to create bubbles because wasteful spending by government and the private sector is necessary to create employment. Without waste and profligacy, unemployment will persist or even rise. Alan Blinder has the temerity to point out what free-market economists noticed years ago – that the money created by Bernanke was mostly sitting idle in excess bank reserves because the Fed had chosen to pay interest on excess reserves. But Blinder is too gentlemanly to ask the obvious question: If the money creation is supposed to be “economic stimulus,” why has Bernanke prevented the money from actually stimulating?

These Keynesian economists are the farthest thing from free-market, laissez faire doctrinaires. But they are not about to give Ben Bernanke a passing grade merely for showing up, trying hard and looking very busy.

To be sure, Goolsbee does make a case that Bernanke actually succeeded in stimulating the U.S. economy. He names two of his colleagues, fellow attendees at the AEA convention, whose “research indicates that [Bernanke’s] Fed policies have helped the economy, albeit modestly… they lowered long-term Treasury rates by about 30 basis points and a bit more for mortgage spreads and corporate bond yields…Americans were able to refinance their homes at more affordable rates, and the drop led to an increase in consumer spending on automobiles and other durables.” Fifty years ago, John Maynard Keynes’ picture appeared on the cover of Time Magazine as an avatar of the end of the business cycle. Now, our Fed prosecutes a policy characterized by a leading English central banker as “the greatest government-bond bubble in history,” and economists have to do research in order to dig up “modest benefits” of the policy that would otherwise go unnoticed. And Goolsbee offers them up with a straight face as the blessings that justify our gratitude to Ben Bernanke.

Bernanke and Inflation

“The QE Era did not create inflation. Not even close. The people who said it would were looking only at the growth in the monetary base… the people arguing that QE means simply printing money (it doesn’t, really) didn’t recognize that the policy was simply offsetting the reverse printing of money resulting from the tight credit channels in the damaged financial system.” Milton Friedman devoted the bulk of his career to refuting the claims of this type of thinking; it would require a lengthy article to review his insights and a book-length analysis to review the economics issues raised by Goolsbee’s nonchalant assertions. But one sentiment popularized by Friedman suffices to convey the concern of “the people” Goolsbee dismisses so condescendingly: “Inflation is always and everywhere a monetary phenomenon.”

At no point in human history has a monetary expansion like Bernanke’s occurred without leading to hyperinflation. So Bernanke’s critics are not a gaggle of tinfoil-hat-sporting, tennis-shoe-wearing conspiracy theorists. They have history on their side. Goolsbee’s confident assurance that Bernanke leaves office with inflation under control is based on a planted axiom the size of an iceberg; namely, that Bernanke’s successor(s) can somehow corral the several trillion dollars of excess reserves still loitering around the financial system before they emerge into circulation in the form of expenditures chasing a limited stock of goods and services. But that’s only the beginning; the Fed must also conduct this money wrangling in such a way as to keep interest rates from rising too greatly and thereby dealing the economy a one-two death blow of overwhelming government debt service and private-sector constriction of economic activity. It is not immediately obvious how this might be accomplished.

Friedman made a case that the Great Depression began in the early 1930s with bank failures that had a multiple contractionary effect on the U.S. money supply. Like generals always fighting the last war, the Fed has since been grimly determined not to be hung for monetary tightness. As F.A. Hayek pointed out, a central bank that always errs on the side of loose money and inflation and never on the side of tight money or deflation will inevitably bias its policy toward inflation. That is the status quo today. Japan’s longtime low inflation is miscalled “deflation,” thereby providing a rhetorical justification for revving up the inflationary printing press. A similar boomlet is building here in the U.S.

Presumably, this explains Goolsbee’s reference to QE credit creation as an offset to credit destruction. But whether you accept Friedman’s analysis or not, Goolsbee’s rationale doesn’t hold water. The bank bailouts of 2008-09 – which were forced on sound banks and shaky ones alike by the Fed and the Treasury – were explicitly sold as a means of guaranteeing financial liquidity. QE did not come along until mid-2010. By then, banks had already repaid or were repaying TARP loans. Thus, Goolsbee cannot sell the QE Era as the solution to a problem that had already been solved. Instead, the evidence favors QE as the palliative for the financial problems of the U.S. Treasury and the spending addiction of the U.S. Congress – matters that Goolsbee delicately overlooks.

Bernanke and Greenspan: The Perils of Premature Congratulation

When Alan Greenspan left office, he had presided over nearly two decades of economic prosperity. The news media had dubbed him “The Maestro.” It is not hard to understand why he was showered with accolades upon retirement. Yet within a few short years his reputation was in tatters. Bernanke gave us an industrial-strength version of Greenspan loose-money policies. But the economy spent most of Bernanke’s tenure in the tank. And Bernanke leaves office having bequeathed us a monetary sword of Damocles whose swing leaves our hair blowing in its breeze.

With the example of Greenspan still fresh in mind, we can justifiably withhold judgment on Bernanke without being accused of rank political prejudice.

Bernanke as Savior

“…We should all be able to agree that fashion standards during a polar vortex shouldn’t be the same as in normal times.” Goolsbee is suggesting that Bernanke has adopted the stern measures called for by the hard times thrust upon him. This is indeed the leitmotiv for economic policy throughout the Obama Administration, not merely monetary policy – hey, just imagine how much worse things could have been, would have been, had we not done what we did. In order for this alibi to stand up, there must be general agreement about the nature and size of the problem(s) and the remedy(ies). Without that agreement, we cannot be sure that Bernanke hasn’t worsened the situation rather than helping it – by addressing non-existent problems and/or applying inappropriate solutions.

In this case, we have had only the word of Chairman Bernanke and Treasury Secretary O’Neill (under President Bush) that economic collapse was threatened in 2008. Despite the wild talk of imminent “meltdown,” none occurred. Indeed, there is no theoretical event or sequence that would meet that description in economics. General economic activity worsened markedly – after the bailout measures were authorized by Congress. The emergency stimulus program did not affect this worsening, nor did it effect the official recovery in June 2009; stimulus funds were so slow to reach the economy that the recovery was well underway by the time they arrived.

The QE program itself has been advertised as “economic stimulus” but is notable for not living up to this billing. (To be sure, this is misleading advertising for the reasons cited above.) If anybody feels grateful to Bernanke for launching it, it is presumably officials of the Treasury and Congress – the former because QE prevented interest rates from rising to normal levels that would have swamped the federal budget in a debt-service tsunami, the latter because the precious spending programs beloved of both parties were spared. But Goolsbee comes nowhere within sight or shouting distance of these financial truths.

It makes sense to hail a savior only when you have reached safety. We haven’t even crossed the icy waters yet, because we’ve had the benefits – tenuous though they’ve been – of QE without having to bear the costs. In other words, the worst is yet to come. Bernanke has made all of us protagonists in an old joke. A man jumps out of a skyscraper. As he falls toward earth, the inhabitants of the building on each successive lower floor hear him mutter, “Well – so far, so good.”

The Politicization of Economics

Why make so much of Austan Goolsbee’s valedictory salute to Ben Bernanke? If the quality of Bernanke’s economic policy is a sunk cost at this point, doesn’t that also moot our assessment of his job performance? If Austan Goolsbee has badly misjudged that performance, that doesn’t say much for Goolsbee, but why should we care? After all, Goolsbee is no longer employed by the Obama Administration; he is now safety ensconced back in academia.

Goolsbee’s judgments matter because they are clearly motivated by politics. They are part of a disturbing pattern in which liberal economists provide a thin veneer of economics – or sometimes no economics at all – to cover their espousal of left-wing causes. Goolsbee pooh-poohs the claim that QE was both dangerous and unnecessary, claiming that the rise in the stock market is not a bubble because it has “tracked increases in corporate earnings.” But earlier in the same article, Goolsbee claimed that QE lowered long-term interest rates on Treasuries and corporate bonds (thus reducing costs of corporate finance) and increased spending on consumer durables. So QE induced increases in corporate earnings that wouldn’t otherwise have occurred, causing increased stock prices – but is absolved from charges of creating a stock bubble because the stock prices were caused by autonomous increases in corporate earnings? Goolsbee claims credit for QE on Bernanke’s behalf at one stage, and then disclaims QE’s influence on exactly the same point at another. This is the type of circular contradiction masquerading as economics that Goolsbee and other Keynesians use to sell their politics.

“Forgoing the Fed’s unconventional monetary policies – inviting real and quantifiable damage to the economy – just to prevent the possibility of a potentially dangerous bubble forming somewhere in the economy would have been cruel and unnecessary,” Goolsbee concludes. Foregoing the “modest benefits” that Goolsbee’s pals managed to dig up merely because the Fed had to create “the greatest government-bond bubble in history” in order to generate them would have been “cruel and unnecessary.” Oh, wait – what about the loss of interest income suffered by hundreds of millions of Americans – many of them retirees, the disabled and other fixed-income investors – thanks to the zero-interest-rate policy ushered in by the QE Era? Was this cruel and/or unnecessary? Goolsbee delicately avoids the subject.

But Goolsbee’s fellow Keynesian, Paul Krugman, is not so circumspect. Krugman comes right out and says that nobody has the right to expect a positive interest return on safe assets while the economy was in a depression; they can either make do with an infinitesimal interest return or lose the value of their money to inflation. (In the same blog post, Krugman had previously accused his critics of callous indifference to the pain caused by business liquidations in a depression.)

This is not economics. It is half-baked value judgment hiding behind the mask of social science. Similarly, Austan Goolsbee’s evaluation of Ben Bernanke’s term as Federal Reserve Chairman may have the imprimatur of economics, but it lacks any of the substance.

DRI-234 for week of 11-17-13: Economists Start to See the Light – and Speak Up

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Economists Start to See the Light – and Speak Up

In order for dreadful economic policies to be ended, two things must happen. Economists must recognize the errors – then, having seen the light, they must say so publicly. For nearly five years, various economists have complained about Federal Reserve economic policies. Unfortunately, the complaints have been restrained and carefully worded to dilute their meaning and soften their effect. This has left the general public confused about the nature and degree of disagreement within the profession. It has also failed to highlight the radicalism of the Fed’s policies.

Two recent Wall Street Journal economic op-eds have broken this pattern. They bear unmistakable marks of acuity and courage. Both pieces focus particularly on the tactic of quantitative easing, but branch out to take in broader issues in the Fed’s conduct of monetary policy.

A Monetary Insider Kneels at the Op-Ed Confessional to Beg Forgiveness

Like many a Wall Street bigwig, Andrew Huszar has led a double life as managing director at Morgan Stanley and Federal Reserve policymaker. After he served seven years at the Fed from 2001-2008, good behavior won him a parole to Morgan Stanley. But when the Great Financial Crisis hit, TARP descended upon the landscape. This brought Huszar a call to return to public service in spring, 2009 as manager of the Fed’s program of mortgage-backed securities purchases. In “Confessions of a Quantitative Easer” (The Wall Street Journal, 11/12/2013), Huszar gives us the inside story of his year of living dangerously in that position.

Despite his misgivings about what he perceived as the Fed’s increasing subservience to Wall Street, Huszar accepted the post and set about purchasing $1.25 trillion (!) of mortgage-backed securities over the next year. This was the lesser-known half of the Fed’s quantitative-easing program, the little brother of the Fed’s de facto purchases of Treasury debt. “Senior Fed officials… were publicly acknowledging [past] mistakes and several of those officials emphasized to me how committed they were to a major Wall Street revamp.” So, he “took a leap of faith.”

And just what, exactly, was he expected to have faith in? “Chairman Ben Bernanke made clear that the Fed’s central motivation was to ‘affect credit conditions for households and businesses.'” Huszar was supposed to “quarterback the largest economic stimulus in U.S. history.”

So far, Huszar’s story seems straightforward enough. For over half a century, economists have had a clear idea of what it meant to stimulate an economy via central-bank purchases of securities. That idea has been to provide banks with an increase in reserves that simultaneously increases the monetary base. Under the fractional-reserve system of banking, this increase in reserves will allow banks to increase lending, causing a pyramidal increase in reserves, money, spending, income and employment. John Maynard Keynes himself was dubious about this use of monetary policy, at least during the height of a depression, because he feared that businesses would be reluctant to borrow in the face of stagnant private demand. However, Keynes’ neo-Keynesian successors gradually came to understand that the simple Keynesian remedy of government deficit spending would not work without an accompanying increase in the money stock – hence the need for reinforcement of fiscal stimulus with monetary stimulus.

Only, doggone it, things just didn’t seem to work out that way. Sure enough, the federal government passed a massive trillion-dollar spending measure that took effect in 2009. But “it wasn’t long before my old doubts resurfaced. Despite the Fed’s rhetoric, my program wasn’t helping to make credit any more accessible for the average American. The banks were only issuing fewer and fewer loans. More insidiously, whatever credit they were issuing wasn’t getting much cheaper. QE may have been driving down the wholesale cost for banks to make loans, but Wall Street was pocketing most of the extra cash.”

Just as worrisome was the reaction to the doubts expressed by Huszar and fellow colleagues within the Fed. Instead of worrying “obsessively about the costs versus the benefits” of their actions, policymakers seemed concerned only with feedback from Wall Street and institutional investors.

When QE1 concluded in April, 2010, Huszar observed that Wall Street banks and near-banks had scored a triple play. Not only had they booked decent profits on those loans they did make, but they also collected fat brokerage fees on the Fed’s securities purchases and saw their balance sheets enhanced by the rise in mortgage-security prices. Remember – the Fed’s keenness to buy mortgage-backed securities in the first place was due primarily to the omnipresence of these securities in bank portfolios. Indeed, mortgage-backed securities served as liquid assets throughout the financial system and it was their plummeting value during the financial crisis that caused the paralyzing credit freeze. Meanwhile, “there had been only trivial relief for Main Street.”

When, a few months later, the Fed announced QE2, Huszar “realized the Fed had lost any remaining ability to think independently from Wall Street. Demoralized, I returned to the private sector.”

Three years later, this is how Huszar sizes up the QE program. “The Fed keeps buying roughly $85 billion in bonds a month, chronically delaying so much as a minor QE taper. Over five years, its purchases have come to more than $4 trillion. Amazingly, in a supposedly free-market nation, QE has become the largest financial-market intervention by any government in world history.”

“And the impact? Even by the Fed’s sunniest calculations, aggressive QE over five years has generated only a few percentage points of U.S. growth. By contrasts, experts outside the Fed…suggest that the Fed may have [reaped] a total return of as little as 0.25% of GDP (i.e., a mere $40 billion bump in U.S. economic output).” In other words, “QE isn’t really working” –

except for Wall Street, where 0.2% of U.S. banks control 70% total U.S. bank assets and form “more of a cartel” than ever. By subsidizing Wall Street banks at the expense of the general welfare, QE had become “Wall Street’s new ‘too big to fail’ policy.”

The Beginning of Wisdom

Huszar’s piece gratifies on various levels. It answers one question that has bedeviled Fed-watchers: Do the Fed’s minions really believe the things the central bank says? The answer seems to be that they do – until they stop believing. And that happens eventually even to high-level field generals.

It is obvious that Huszar stopped drinking Federal Reserve Kool-Aid sometime in 2010. The Fed’s stated position is that the economy is in recovery – albeit a slow, fragile one – midwived by previous fiscal and monetary policies and preserved by the QE series. Huszar doesn’t swallow this line, even though dissent among professional economists has been muted over the course of the Obama years.

Most importantly, Huszar’s eyes have been opened to the real source of the financial crisis and ensuing recession; namely, government itself. “Yes, those financial markets have rallied spectacularly…but for how long? Experts…are suggesting that conditions are again ‘bubble-like.'”

Having apprehended this much, why has Huszar’s mind stopped short of the full truth? Perhaps his background, lacking in formal economic training, made it harder for him to connect all the dots. His own verdict on the failings of QE should have driven him to the next stage of analysis and prompted him to ask certain key questions.

Why did banks “only issu[e] fewer and fewer loans”? After all, this is why QE stimulated Wall Street but not Main Street; monetary policy normally provides economic stimulus by inducing loans to businesses and (secondarily) consumers, but in this case those loans were conspicuous by their absence. The answer is that the Fed deliberately arranged to allow interest payments on excess reserves it held for its member banks. Instead of making risky loans, banks could make a riskless profit by holding excess reserves. This unprecedented state of affairs was deliberately stage-managed by the Fed.

Why has the Fed been so indifferent to the net effects of its actions, instead of “worry[ing] obsessively about the costs versus the benefits”? The answer is that the Fed has been lying to the public, to Congress and conceivably even to the Obama Administration about its goals. The purpose of its actions has not been to stimulate the economy, but rather to keep it comatose (for “its” own good) while the Fed artificially resuscitates the balance sheets of banks.

Why did the Fed suddenly start buying mortgage-backed securities after “never [buying] one mortgage bond…in its almost 100-year history”? Bank portfolios (more particularly, portfolios of big banks) have been stuffed to the gills with these mortgage-backed securities, whose drastic fall in value during the financial crisis threatened the banks with insolvency. By buying mortgage-backed securities like they were going out of style, the Fed increases the demand for those securities. This drives up their price. This acts as artificial respiration to bank balance sheets, just as Andrew Huszar relates in his op-ed.

The resume of Fed Chairman Ben Bernanke is dotted with articles extolling the role played by banks as vital sources of credit to business. Presumably, this – rather than pure cronyism, as vaguely hinted by Huszar – explains Bernanke’s obsession with protecting banks. (It was Bernanke, acting with the Treasury Secretary, who persuaded Congress to pass the enormous bailout legislation in late 2008.)

Why has “the Fed’s independence [been] eroding”? There is room for doubt about Bernanke’s motivations in holding both short-term and long-term interest rates at unprecedentedly low levels. These low interest rates have enabled the Treasury to finance trillions of dollars in new debt and roll over trillions more in existing debt at low rates. At the above-normal interest rates that would normally prevail in our circumstances, the debt service would devour most of the federal budget. Thus, Bernanke is carrying water for the Treasury. Reservoirs of water.

Clearly, Huszar has left out more than he has included in his denunciation of QE. Yet he has still been savaged by the mainstream press for his presumption. This speaks volumes about the tacit gag order that has muffled criticism of the Administration’s economic policies.

It’s About Time Somebody Started Yellin’ About Yellen

Kevin Warsh was the youngest man ever to serve as a member of the Federal Reserve Board of Governors when he took office in 2006. He earned a favorable reputation in that capacity until he resigned in 2011. In “Finding Out Where Janet Yellen Stands” (The Wall Street Journal, 11/13/2013), Warsh digs deeper into the views of the new Federal Reserve Board Chairman than the questions on everybody’s lips: “When will ‘tapering’ of the QE program begin? and “How long will the period of ultra-low interest rates last?” He sets out to “highlight – then question – some of the prevailing wisdom at the basis of current Fed policy.”

Supporters of QE have pretended that quantitative easing is “nothing but the normal conduct of monetary policy at the zero-lower-bound of interest rates.” Warsh rightly declares this to be hogwash. While central banks have traditionally lowered short-term interest rates to stimulate investment, “the purchase of long-term assets from the U.S. Treasury to achieve negative real interest rates is extraordinary, an unprecedented change in practice… The Fed is directly influencing the price of long-term Treasurys – the most important asset in the world, the predicate from which virtually all investment decisions are judged.”

Since the 1950s, modern financial theory as taught in orthodox textbooks has treated long-term U.S. government bonds as the archetypal “riskless asset.” This provides a benchmark for one end of the risk spectrum, a vital basis for comparison that is used by investment professionals and forensic economists in court testimony. Or rather, all this used to be true before Ben Bernanke unleashed ZIRP (the Zero Interest Rate Policy) on the world. Now all the finance textbooks will have to be rewritten. Expert witnesses will have to find a new benchmark around which to structure their calculations.

Worst of all, the world’s investors are denied a source of riskless fixed income. They can still purchase U.S. Treasurys, of course, but these are no longer the same asset that they knew and loved for decades. Now the risk of default must be factored in, just as it is for the bonds of a banana republic. Now the effects of inflation must be factored in to its price. The effect of this transformation on the world economy is incalculably, unfavorably large.

Ben Bernanke has repeatedly maintained that the U.S. economy would benefit from a higher rate of inflation. Or, as Warsh puts it, that “the absence of higher inflation is sufficient license” for the QE program. Once again, Warsh begs to differ. Here, he takes issue with Bernanke’s critics as much as with Bernanke himself. “The most pronounced risk of QE is not an outbreak of hyperinflation,” Warsh contends. “Rather, long periods of free money and subsidized credit are associated with significant capital misallocation and malinvestment – which do not augur well for long-term growth or financial stability.”

Déjà Va-Va-Vuum

Of all the hopeful signs to recently emerge, this is the most startling and portentous. For centuries – at least two centuries before John Maynard Keynes wrote his General Theory and in the years since – the most important effect of money on economic activity was thought to be on the general level of prices; i.e., on inflation. Now Warsh is breaking with this time-honored tradition. In so doing, he is paying long-overdue homage to the only coherent business-cycle theory developed by economists.

In the early 1930s, F.A. Hayek formulated a business-cycle theory that temporarily vied with the monetary theory of John Maynard Keynes for supremacy among the world’s economists. Hayek’s theory was built around the elements stressed by Warsh – capital misallocation and malinvestment caused by central-bank manipulation of the money supply and interest rates. In spite of Hayek’s prediction of the Great Depression in 1929 and of the failure of the Soviet economy in the 1930s, Hayek’s business-cycle theory was ridiculed by Keynes and his acolytes. The publication of Keynes’ General Theory in 1936 relegated Hayek to obscurity in his chosen profession. Hayek subsequently regained worldwide fame with his book The Road to Serfdom in 1944 and even won the Nobel Prize in economics in 1974. Yet his business-cycle theory has survived only among the cult of Austrian-school economists that stubbornly refused to die out even as Keynesian economics took over the profession.

When Keynesian theory was repudiated by the profession in the late 1970s and 80s, the Austrian school remained underground. The study of capital theory and the concept of capital misallocation had gone out of favor in the 1930s and were ignored by the economics profession in favor of the less-complex modern Quantity Theory developed by Milton Friedman and his followers. Alas, monetarism went into eclipse in the 80s and 90s and macroeconomists drifted back towards a newer, vaguer version of Keynesianism.

The Great Financial Crisis of 2008, the subsequent Great Recession and our current Great Stagnation have made it clear that economists are clueless. In effect, there is no true Macroeconomic theory. Warsh’s use of the terms “capital misallocation” and “malinvestment” may be the first time since the 1930s that these Hayekian terms have received favorable mention from a prominent figure in the economic Establishment. (In addition to his past service as a Fed Governor, Warsh also served on the National Economic Council during the Bush Administration.)

For decades, graduate students in Macroeconomics have been taught that the only purpose to stimulative economic policies by government was to speed up the return to full employment when recession strikes. The old Keynesian claims that capitalist economies could not achieve full employment without government deficit spending or money printing were discredited long ago. But this argument in favor of artificial stimulus has itself now been discredited by events, not only in the U.S. and Europe but also in Japan. Not only that, the crisis and recession proceeded along lines closely following those predicted by Hayek – lavish credit creation fueled by artificially low interest rates long maintained by government central banks, coupled with international transmission of capital misallocation by flexible exchange rates. It is long past time for the economics profession to wrench its gaze away from the failed nostrums of Keynes and redirect its attention to an actual theory of business cycles with a demonstrated history of success. Warsh has taken the key first step in that direction.

The Rest of the Story

When a central bank deliberately sets out to debase a national currency, the shock waves from its actions reverberate throughout the national economy. When the economy is the world’s productive engine, those waves resound around the globe. Warsh patiently dissects current Fed policy piece by piece.

To the oft-repeated defense that the Fed is merely in charge of monetary policy, Warsh correctly terms the central bank the “default provider of aggregate demand.” In effect, the Fed has used its statutory mandate to promote high levels of employment as justification for assuming the entire burden of economic policy. This flies in the face of even orthodox, mainstream Keynesian economics, which sees fiscal and monetary policies acting in concert.

The United States is “the linchpin in the international global economy.” When the Fed adopts extremely loose monetary policy, this places foreign governments in the untenable position of having either to emulate our monetary ease or to watch their firms lose market share and employment to U.S. firms. Not surprisingly, politics pulls them in the former direction and this tends to stoke global inflationary pressures. If the U.S. dollar should depreciate greatly, its status as the world’s vehicle currency for international trade would be threatened. Not only would worldwide inflation imperil the solidity of world trade, but the U.S. would lose the privilege of seigniorage, the ability to run continual trade deficits owing to the world’s willingness to hold American dollars in lieu of using them to purchase goods and services.

The Fed has made much of its supposed fidelity to “forward guidance” and “transparency,” principles intended to allow the public to anticipate its future actions. Warsh observes that its actions have been anything but transparent and its policy hints anything but accurate. Instead of giving lip service to these cosmetic concepts, Warsh advises, the Fed should simply devote its energies to following correct policies. Then the need for advance warning would not be so urgent.

Under these circumstances, it is hardly surprising that we have so little confidence in the Fed’s ability to “drain excess liquidity” from the markets. We are not likely to give way in awed admiration of the Fed’s virtuosity in monetary engineering when its pronouncements over the past five years have varied from cryptic to highly unsound and its predictions have all gone wrong.

Is the Tide Turning?

To a drowning man, any sign that the waters are receding seems like a godsend. These articles appear promising not only because they openly criticize the failed economic policies of the Fed and (by extension) the Obama Administration, but because they dare to suggest that The Fed’s attempt to portray its actions as merely conventional wisdom is utterly bogus. Moreover, they imply or (in Kevin Warsh’s case) very nearly state that it is time to reevaluate the foundations of Macroeconomics itself.

Is the tide turning? Maybe or maybe not, but at last we can poke our heads above water for a lungful of oxygen. And the fresh air is intoxicating.

DRI-312 for week of 9-29-13: Suppose They Gave a Government Shutdown and Nobody Cared?

An Access Advertising EconBrief:

Suppose They Gave a Government Shutdown and Nobody Cared?

Midnight on Tuesday, Oct. 1, 2013 is the deadline for the shutdown of the federal government. That is the start of the new federal fiscal year. The U.S. Constitution specifies that Congress must authorize spending by the executive branch. Strange as it seems to a country by now inured to executive and regulatory high-handedness, the government cannot legally initiate operations by writing checks on its own hook. Fiscal delinquency, delay and deceit have long been the hallmarks of Congressional action, so it seems only fitting that Congress has failed to agree on the spending authorizations for departments that would get the federal government up and running in the New Year. And this year’s calendar offers a special treat, since the Oct. 17 deadline for default looms on the horizon as the next bureaucratic drop-dead date for civilization as we know it.

Amid the breathless media countdown to Armageddon, a sober pause for introspection is in order. How big an emergency is the federal-government shutdown, really? What underlying significance does a government shutdown have? How did we reach this position? Has the underlying economic significance of our situation been correctly conveyed by commentators and news media?

OMG! The Federal Government is About to Shut Down! Oh, Wait, Time for Vacation…

The attitude of Congressional representatives toward the prospect of government shutdown might best be compared to that of college students facing final exams. The exam schedule is announced at the beginning of the semester; indeed, it is printed in the course catalog distributed at registration. The course syllabus carefully explains the importance of the final to the student’s grade. The student knows the format of the exam, its location and exact time of day.

So, having had nearly four months to prepare and all the advance warning anybody could ask for, students are well versed, confident and unruffled in the waning days of the semester, right? On the night before the exam, they spend a short time reviewing basic ideas before retiring to get a good night’s sleep, to arise refreshed and eager to meet their task on final-exam day, don’t they? And they pass the exam with flying colors?

No, students generally seek out any excuse to avoid studying the material – and excuses emerge in profusion. As time passes and the semester ages, the knowledge of their approaching fate weighs on students’ minds, producing a buildup of anxiety and kinetic energy in their bodies. This demands an outlet, and late semester is a popular time for beer busts and other recreational modes of escape. The waning days before the final exam are spent in frantic efforts to complete course work and accomplish several months’ worth of study in a few days. The culmination of this crash program arrives on execution eve, when the students cram as many isolated facts as possible into their brain cells, relying on short-term memory to pinch-hit for solid comprehension. The surprising success rate of this modus operandi is owed less to its inherent effectiveness than to the grade inflation that has overwhelmed higher education in recent decades.

Anybody who expected their Congressional representative to behave in a more mature, sensible fashion than a college underclassman has been bitterly disillusioned by experience. Consider this latest example of budget brinkmanship.

The end of the fiscal year is not a national secret. Congress has known all year it was coming. The issues dividing the two major parties were well-known from the first day; ObamaCare has been a dinosaur-sized-bone of contention since its proposal and passage in 2010 and shocking reaffirmation by the Supreme Court in 2011. There was ample time to resolve differences or remove the legislation as a political roadblock to process.

As the year wound down, it became increasingly clear that opponents were eyeball to eyeball, each waiting for the others to blink. Now it was August, with only two months left in which to stave out a shutdown. When the going get tough, the tough… go on vacation – which was exactly what Congress did, for five weeks.

For the last week, leaders like Senate Majority Leader Harry Reid (D-Nevada) and Republican Ted Cruz have suddenly come alive with frantic last-ditch efforts. Each side has crafted and passed proposals (in the Democrat-controlled Senate and the Republican House) that the other side has torpedoed. At this writing, we are down to the last-minute cramming… but it should not escape notice that Sen. Reid was not too appalled by the prospect of shutdown to leave town the weekend after superintending the defeat of Rep. Cruz’s proposal in the Senate.

A few of the more cynical commentators have observed that we have been down this road before without careening off the highway and down a mountainside into oblivion. One set of talking points refers to this as our third experience with actual shutdown, but this is far from true. In fact, the federal government has survived 19 previous shutdowns – 17 since 1977 alone, according to the Congressional Research Service. Most have lasted a few days; the most recent (and famous) one in 1996 lasted for 21 days. So much for the artificially contrived atmosphere of urgency surrounding this one, which has been another production of political theater brought to you by your national news media.

Is There a Point to the Shutdown? If So, What is It?

It should be obvious that the hype surrounding the shutdown is phony. Even if we make allowances for the timing coincidence of the fiscal-year dividing line and debt-ceiling deadline, the attention paid to the shutdown is out of all proportion to its real effects on American well-being. But even though the shutdown may be relatively innocuous in its effects, that does not make it a good idea. What does it accomplish – ostensibly or actually?

It goes without saying that detractors of the Tea Party and the Republican Congressional leadership foresee nothing good coming of the shutdown. Since these are the people who got America into the mess that now plagues it – or stood by while that happened – we can disregard their opinions.

If there is an overriding goal of those who drove the events leading to the shutdown, it is opposition to ObamaCare. This opposition has taken the form of attempts to “defund” it; that is, to deny the Obama Administration the money necessary to implement the program. Were this successful, the program would remain on the books de jure as law, but would be repealed de facto by the lack of funds to run it. The most direct means taken to achieve this end is by passing a spending authorization bill containing a rider that defunds the Affordable Care Act. The problem with this measure is that the President will never sign this bill; ObamaCare is the signature legislation of his presidency.

Plan B of the defunders has been to replace that defunding rider with one that delays implementation of ObamaCare provisions for individual citizens by one year. This is directly analogous to the delay instituted by the Obama administration itself for businesses; in effect, it simply gives private individuals the same one-year reprieve given to employers by the President himself. This measure not only has the virtue of symmetry but also of fairness and logistical convenience. It is not clear why the bill should be delayed for businesses and not for everybody else. The state exchanges that would enable individuals to acquire health insurance are not up and running anyway in several states, so this would give the system more time to iron out the kinks. And this delay is entirely legal, being instituted by the Congress and submitted for Presidential signature; the business delay was a flagrantly illegal action imposed by Presidential fiat.

But President Obama is not about to agree to this compromise measure, either. He knows that the longer ObamaCare is postponed, the longer opposition will have to build and the longer its defects will have to become manifest. Once in place, a national system this massive and bureaucratic will be almost impossible to dislodge if only due to the inertia that will set in. The President only delayed applying its business provisions out of direst necessity; everybody was so unprepared that imposition would have led to complete fiasco. So Obama wants to get half of ObamaCare going while the going is good – or at least feasible.

Republic Speaker of the House John Boehner is already confronted by panic in the ranks. Republican representatives have hardly faced the first unfriendly fire from the news media – accusing them of irresponsibly jeopardizing the welfare of the nation for their own petty political purposes – before bolting for cover. Boehner’s queries as he gives them the flat of his sword are: What is this all about if not standing on principle against the President’s program? If we can’t work for the repeal of a terrible law as soundly unpopular as ObamaCare, when will we ever oppose the President? If now isn’t the time to stand firm against policies that are spending the country into the ground and destroying the heritage of our children, when will a better time come around? Over 30 years ago, President Ronald Reagan asked: If not now, when? Well, we didn’t do it then. If we don’t reform the budget now, when?

And those are indeed the relevant questions. Most Republicans oppose ObamaCare, all right; they have enough political courage to stand up against a law when the polls proclaim it heavily unpopular. But ObamaCare is merely the tip of the spending iceberg; the entitlement programs lie jutting beneath the surface waiting to scuttle the most unsinkable of reformers. There is no sign of Republicans boarding icebreakers, kissing wives and children goodbye and signing on for the duration of the voyage to clear the sea lanes of entitlements.

And Now for Some Opinion Completely Different

Holman Jenkins of The Wall Street Journal is a commentator not noted for his sunny optimism. Nevertheless, his take on the federal-budget stalemate is decidedly more upbeat than others commonly bruited. “What if, 10 years ago, Greece had made itself a laughingstock, sacrificed its credibility, brought shame on itself – all phrases used against Washington this week – by shutting down its government because certain legislators saw ideological and electoral rewards to be gained from making a fuss over unsustainable spending? Greek TV hosts would have shouted ‘Athens is broken!'”

Instead, as Jenkins knows only too well, Greece went sleepily on its corrupt, lazy, insouciant way, only to collapse in a heap nearly a decade later. Meanwhile, Americans today “all shake a fist at Washington, denouncing its irresponsibility because politicians are ‘playing politics’ with the debt ceiling and government shutdown.” But “then again, politics is how we govern ourselves. It’s better than despotism not because each moment is a model of stately order and reason, because America is a diverse, fractious society. The only way it works is by the endless grinding out of political compromises amid shrieking and making threats and turning blue.”

Jenkins anticipates the typical facile rejoinder. “The usual suspects at this point will be stamping their feet and insisting the U.S. isn’t Greece, as if this is an insight. No country can borrow and spend infinite amounts of money, and no political system is immune to the incentive to keep trying anyway. Herein lies the real point that applies as much to Washington as to Athens.”

“It would be nice if today’s fight were genuinely about the future. Oh, wait, that’s exactly what the ObamaCare fight is about. By trying to stop a brand new entitlement before it gets started, in a country already palpably and indisputably committed to more entitlement spending than it wants to pay for, those radical House Republicans aren’t trying to chop current spending amid a sluggish recovery (however much one begins to doubt that pump-priming from Washington is the solution the economy needs). Those terrible House Republicans aren’t trying to force colleagues to commit painful votes to take away established goodies from established voting blocs – votes that neither Republicans nor Democrats have the slightest yearning to cast.”

“Those disgraceful House Republicans have made the fight exactly about the long term. Where’s the grudging approval from our Keynesian friends who constantly say immediate spending must be protected and reform saved for the long term?” Again, Jenkins knows full well that Keynesian economics is no longer a putatively consistent set of theoretical propositions; it is now a policy admonition in search of a theory and for sale to any political sponsor willing to fork over lucrative, visible jobs to Keynesian economists.

“Not only will there by more such shutdowns,” Jenkins predicts. “What passes for progress each time will be tiny – until it’s not. The 2011 sequester, which caused critics to engage in choruses of disapproval and the S&P to downgrade U.S. debt, set us on a path to today’s modestly smaller current deficits. This week’s peculiar fight may be resolved by a near-meaningless repeal of ObamaCare’s self-defeating medical-device tax – a teensy if desirable adjustment, having no bearing on the deficit tsunami that begins when the baby boomers start demanding their benefits.”

Jenkins’s peroration combines elements of Churchill and Pericles. “We are at the beginning of the beginning. Yet the birth pangs of entitlement reform that will one day inspire the world (as we did with tax reform in ’80s) may be what we’re witnessing.” Hence the title of the column: “Behind the Noise, Entitlement Reform.”

Too Little, Too Late

Holman Jenkins’s vision is seductive, but unconvincing. Its visceral appeal lies in its pragmatism and its familiarity. Pragmatism is the great American virtue. We have grown up learning to accept and adapt to incremental change. Surely the changes necessary to cope with the downsizing of the welfare state will be just one more set of adjustments – painful but bearable. How many times have we heard Cassandras prophesy doom? How many times has it appeared? This is apparently the comforting set of rationalizations that insulates us from the truth of our situation.

Unfortunately, there is no reason to believe that a long series of small changes will be both timely and sufficient to our purpose. Not only has the Obama Administration’s fiscal policies shifted the velocity of fiscal decline to warp speed, but its monetary policies have changed our major problem from financial crisis to monetary collapse. Financial crisis is something that both individual countries and world systems recover from. Monetary collapse can lead to the destruction of a nation’s economy and the end of the civil order. We not only have to change our ways, we must reverse course by 180 degrees. And do it quickly.

It seems that Jenkins envisions entitlement reform from the austere perspective of an actuary contemplating the future of a program like Social Security. Tut-tut, the actuary admonishes, this program will be bankrupt in another 20 years or so. Well, in 20 years, a solid plurality of Wall Street Journal readers will be dead or near death. Quite a few will be financially independent of the program. Most of the rest view 20 years hence as imperceptibly distant – ample time to recover from the financial improvidence of youth.

But the real crisis on our trip planner is not actuarial. Social Security affects it long before it actually becomes insolvent because its unfunded status will be factored into the calculations of bond traders, credit-rating agencies and interest-rate setters. We may or may not be at Jenkins’s “beginning of the beginning,” but we are certainly not standing in the starting blocks in terms of debt. Government at every level is in hock up to its hairline. The private sector has been making a valiant effort to deleverage – and for its pains has caught hell from Keynesian economists who lecture us about the evils of saving in the middle of a recession. (Just prior to the Great Recession, the same people were decrying our “consumption binge” and running public-service ads begging us to save more.) American banks have trillions loitering in excess reserves, just spoiling for the chance to torch the value of the dollar at home and abroad. Foreign holders of dollars and dollar-denominated assets are dying for a convenient chance to unload them. Business forecasters need binoculars to view the upside potential of U.S. interest rates. And when interest rates skyrocket, interest payments on the federal debt will crowd out practically everything else on the docket, making the budget wars of today look like Sunday-school theology debates. The endpoint of this process is monetary collapse, when the U.S. dollar is abandoned as a medium of exchange, unit of account and store of value.

Oh, and just in case the foregoing doesn’t fill you with a sense of dread, there’s the little matter of international “currency war” to ponder. During the Great Depression, many nations used monetary expansion to deliberately trash the value of their own currencies. Their aim was to make their goods look cheap to foreigners, thereby hiking their number and value of their exports and increasing employment in their export industries. Since their depreciated domestic currency would also buy fewer imports, this would supposedly encourage the citizenry to buy fewer goods from abroad, thereby increasing domestic employment in import-competing industries. This game plan is well-known to economic historians as the “beggar thy neighbor” strategy. Its inherent flaw is that it can work if, and only if, only one nation employs it. When all or most nations do it simultaneously, the effects cancel each other out in the currency market and the only result is that international trade evaporates – which is roughly what did happen during the Depression. Since international trade is a good thing which makes practically everybody better off, its virtual elimination was a disaster for everybody. And guess what? The rest of the world, watching Ben Bernanke and the Fed at work creating money like there’s no tomorrow, may well suspect the U.S. of trying just this tactic. Whether they’re right or wrong is beside the point, since it is their belief that will determine whether they retaliate by starting a trade war that mimics the devastation of the 1930s.

It is barely possible that Congress might embark on a program of haphazard, gradual deficit reduction a la Jenkins. But a thoroughgoing reform of the process is not in the cards. Thus, the danger is not a collapse caused by a government shutdown. The danger is a collapse caused by the failure to shut the government down. It is government at all levels that has turned itself into a machine for spending citizens’ money to benefit employees without providing substantial benefits to the citizens. Since there is virtually no competition for government services, there is little or no way to gauge whether any government good or service is worth what we have to pay to get it. So government just keeps rolling along, like Old Man River, carrying us all along with the flow.

The mass delusion afflicting America is cognitive dissonance. Most of us agree with Jenkins that no government can increase spending indefinitely. Yet we do not admit that this requires our government to actually cut spending for the purposes that (we believe) benefit us – or, at least, we do not admit this necessity in our lifetime. The same people who normally consider government to be intrusive, inept and unproductive magically reverse their position 180 degrees and assume that government is efficient and productive when pursuing their pet project, benefitting them and saving the world from their latest hobgoblin. This is the politico-economic equivalent of William Saroyan’s lament that everybody had to die but he had always assumed that an exception would be made in his case.

The dissonance is actually three-sided. We fail to recognize not only its quantitative dimension but also its qualitative side – government’s utter failure to solve problems and produce things of value. Thus, the real entrenched constituency for big government is not its ostensible beneficiaries – the poor, downtrodden, minorities and such. It is the bureaucrats and their minions, who collect paychecks but whose real net contribution to the social product is negative.

Until this dissonance is dispelled, it is idle to blame politicians for acting true to form.

DRI-364 for week of 9-23-12: Revisiting the DRI and Related Economic Indices

An Access Advertising EconBrief:

Revisiting the DRI and Related Economic Indices

Periodically this space has revisited Access Advertising’s Driver Recruiting Index (DRI). This index tries to estimate the real-time ex ante demand for commercial drivers. It samples the classified ads placed to recruit drivers in 32 geographically dispersed major-metropolitan newspapers throughout the U.S. Every now and then, we place the DRI alongside other trucking, transport and freight indices and gauge its movements in relation to indices of overall income and employment.

The DRI in the 2nd and 3rd Quarters

Like the overall economy, the DRI got off to a reasonably fast start after a promising end to 2011. But it soon became clear that, like the U.S. economy, the DRI was going to fall short of expectations (let alone hopes) in 2012. The Index pierced the 200 barrier for the only time so far this year on March 25, flirting with a raw score of 500 (an achievement it exceeded 14 times in 2011).

After that, it has been all downhill. Year-over-year comparisons have occasionally fallen over 20% short of 2011; 10% shortfalls have been commonplace. Driver demand has never really caught fire, peaking in late spring and skipping both the normal summer high and the fall upturn.

Second-quarter GDP growth was also disappointing, ending up at a tepid 1.7%, even below the moderate 2% in first quarter. Although unemployment has now declined fractionally to 8.1%, this reflects only the decline in the size of the labor force. The number of new jobs created has continued to languish.

The only good news has been a Wall Street rally engineered largely in response to the latest quantitative easing by Ben Bernanke’s Federal Reserve. This is probably responsible for a recent upsurge in consumer confidence in the economy.

The DRI as Economic Indicator

If the DRI’s disappointing performance has mirrored that of general economic indicators, this very congruence speaks well for the DRI’s performance as an economic indicator. Trucking handles some two-thirds of all freight by volume and about 80% by value; many production inputs and final goods travel the nation’s roads and highways. We expect changes in trucking activity and driving demand to track overall trends in production, income and employment. (Whether the DRI is or should be a leading, coincident or lagging indicator is a complicated question that will be broached later.)

The DRI continues to display other desirable properties as well. One of those is (relative) stability. The very ubiquity and prominence of trucking strongly suggests that we should not expect to find the Index fluctuating widely from week to week. While trucking firms ordinarily experience high rates of turnover, this is a long-term phenomenon, responsive to demographic factors (average age, cultural shifts) and cyclical variables (wage changes, politico-regulatory changes). A particular trucking firm may well experience a sudden, substantial need for drivers, but this will usually represent a geographic shift of demand that is offsetting in the aggregate. Significant increases or decreases, when they occur, are usually persistent, cyclical changes in trend, not random fluctuations.

For a concrete illustration, compare the DRI with TransCore’s DAT North American Freight Index, which compiles data from the company’s load board network in the U.S. and Canada. Neither the DRI nor the NAFI is seasonally adjusted, but the contrast in variability is stark. Earlier in 2012, NADI racked up this record of month-over-month fluctuations: March 2012 – up 40%, April 2012 – up 3.5%, May 2012 – up 1.7%, June 2012 – down 2%, July 2012 – down 20%, August – up 1.1%. Monthly fluctuations of 20% in the DRI would be observed only at a seasonal or cyclical peak or turning point, and a 40% monthly change is unheard of.

The DRI and Comparable Economic Indicators

Given the importance of trucking in the production chain, it is surprising that the DRI is one of few time-tested, reliable trucking indices – and the only one to track driver demand. A rundown of the others reaffirms our understanding of what makes for a good index and confirms the DRI’s recent congruence with its brethren.

The Cass Freight Index compiles data from the expenditures of 350 of the largest freight shippers. Early in the year, the Index flexed its muscles with a 2.5% increase in February 2012. Then, along with the economy at large, it began to lose vitality. Increases diminished to 2.1% in March, 1.9% in April, 1.8% in May and 1.3% in June. In July, the Index turned negative with a 0.1% decrease, followed by a 1.1% fall in August. Sponsors and analysts cited a buildup of inventories, a fall in international trade and recent declines in manufacturing output as recorded by the Institute of Supply Management’s index, which had fallen for three straight months.

The American Trucking Associations are the Establishment of the trucking industry and Chief Economist Bob Costello is the voice of starched, high-collared authority. The ATA Truck Tonnage Index is perhaps the most widely cited trucking index, not only by private-sector analysts but even by the federal government. Although the ATA’s respect for authority imparts a big-government bias to its occasional obiter dicta, its economic data are accorded the utmost respect.

The TTI’s recent numbers paint the same by-now-familiar picture of a stalling, sluggish trucking sector. March saw a 0.2% increase, April improved to 1.1% but May backtracked to 0.9%. June went back up to 1.1% but July was unchanged. Typically, Costello’s public comments wrapped the language of an economist inside the rhetoric of a politician. He depicted “…an economy that has lost some steam but hasn’t stalled.” The ATA’s corporate commentary was more telling, noting that “…the index… has been moving mostly sideways in 2012.”

The Truck Tonnage Index is an important component in the federal government’s Transportation Services Index (TSI), which is published by the Bureau of Labor Statistics (BLS). For most of 2012, this index has alternated back and forth with little net increase to show for the year. In February, the TSI rose 0.5%, but it fell back 0.8% in March. April brought a modest rebound of 0.2% but in May the Index was unchanged. June and July saw offsetting 0.1% changes.

These indices display the bedrock virtues noted above: stability and congruence with general economic activity and with each other. One of the rising economic forecasting stars of recent years was the Ceridian Pulse of Commerce Index (PCI), compiled by respected econometrician Edward Leamer of UCLA. After recording some lackluster increases earlier this year, the Index ceased publishing somewhat mysteriously following its May release. Ceridian has responded to queries by saying that although the Index does not now publish its results, it is contemplating a return on a subscription basis and is soliciting indications of interest among potential customers.

Is the DRI a Leading, Lagging or Coincident Indicator?

Undergraduate students of economics are taught that economic indicators come in three flavors – leading, coincident and lagging. These indicate whether changes in the indicator lead, accompany or lag changes in the general level of economic activity. Since the unknown future preoccupies our attention, leading indicators are especially studied and prized.

There has long been a casual presumption that trucking indices are, or at least should be, leading indicators. Disruptive phenomena like layoffs and unemployment are presumably necessitated by the accumulation of unsold goods. Since trucks carry goods and the inputs necessary to produce them, freight shipments should register the incidence of cutbacks in production and materials. This is the sort of logic that supports the categorization of trucking as a leading indicator.

Early in its life, though, the DRI was observed to be a lagging indicator. We rationalized this as the caution of recruiters, who – unsure and suspicious of the depth and duration of any increases in freight supply after the Great Recession – waited to verify the persistence of demand before incurring the fixed costs of hiring. In fact, similar behavior had been recorded in connection with the Index of Classified Advertising, an economic index that bears a strong family resemblance to the DRI.

Since leading and lagging indicators are at opposite poles, this plants a seed of skepticism about the traditional taxonomy of economic indicators. Further consideration should nourish that thought.

The inherent logic of leading economic indicators says that they can be used to predict the economic future – or at least the turning points of business cycles. And this is simply impossible.

Anybody who can accurately predict the future onset of a recession – or, for that matter, the end date of one – can earn a fortune by so doing. Anybody who can repeat the performance reliably can become fabulously rich. Business forecasters are not fabulously rich. Ergo, they cannot predict the beginning or ends of recessions. Not reliably, anyway.

This must mean that leading economic indicators do not really lead. Maybe they don’t even indicate. In any case, something isn’t quite kosher. The question is: what?

The Theory of the Business Cycle – Such As It Is

Something else that all undergraduate students of economic statistics and econometrics learn is that economic theory and logic form the basis for all empirical work. Without theory, we cannot know what data to collect or what relationships to posit between the variables that make up the data. So an economic model is borrowed or created to embody the relationships upon which data is collected. Only then can the data gathering and testing begin.

But in business forecasting that runs us smack up against a formidable obstacle. There is no generally accepted business-cycle theory. The categories used by the National Bureau of Economic Research to codify episodes of the business cycle – expansion, peak, contraction and trough – were developed by institutional economist Wesley Mitchell in the early 1900s, based on years of observation and study of past recessions. Unfortunately, observation is not theory.

The national income and product accounts used to compile U.S. economic data were developed later, based largely on the economic categories developed by English economist John Maynard Keynes in his influential work The General Theory of Employment Interest and Money. But Keynes explicitly denied that the General Theory contained any theory of the business cycle. He simply declared that capitalist economies suffered from a chronic shortage of aggregate demand – e.g., private spending by households and producers. He never said why the shortage existed. Government should make up for this shortfall, Keynes maintained, by running budget deficits that increased the aggregate total of aggregate demand or spending. Essentially, government should commit to purchasing whatever volume of output is left unbought by households and producers, so as to insure full employment. Keynes didn’t supply a theory to account for the business cycle, only a purported remedy to cure the symptoms.

Without knowing where the shortfall in spending lies, we cannot predict where to look for leading indicators at any stage of the business cycle. There is one school of thought whose business-cycle theory offers general advice on this point. That is, it doesn’t offer a list of specific industries, sectors or indicators as such, but instead provides advice about where to look for them in general cases.

The Austrian theory of the business cycle pinpoints monetary expansion by government – probably supervised by a central bank – as the proximate culprit behind recessions. By driving interest rate below the “natural rate of interest,” the rate that would equate the saving households and producers want to do, the money creation will make interest rates artificially low. This makes long-lived, capital-intensive production processes artificially attractive to producers. In turn, this creates a “bubble,” or artificial excess prosperity, in the sector thus favored. While it lasts, this bubble can seem deliriously prosperous, almost too good to be true. That is because it is too good to be true, as the drawn-out period of housing prosperity in the U.S. proved. But when the bubble bursts – owing either to a rise in interest rates or a rising burden of debt – the artificially-prosperous sectors are the first to crash. They are the leading indicators of the coming recession.

In general, then, leading indicators are those pertaining to the sectors receiving the artificial encouragement. In the U.S. during the 1990s and early 2000s, this would have been the housing sector. But this does not mean, as many have implied or outright insisted, that the housing sector should be the first to recover its balance. And it does not mean that nobody can recover until the housing sector does. Indeed, the reverse is more nearly true – housing should be the last sector to recover fully. It also means that the stubborn attempts to stage-manage recovery in housing by holding interest rates low and artificially raise housing prices through government purchases of mortgages and securities are counterproductive. After all, this is exactly the process that caused the problem in the first place – repeating it merely enlarges the backlog of adjustments that must occur before recovery can take place.

An Austrian Look at Economic Indicators

The effect of this theory on forecasting practice is striking. Housing becomes a leading indicator for the downturn phase because it is a long-lived production process, extremely sensitive to interest rates. But it is a lagging indicator for the upturn; it cannot recover until all of the bad investments made during the bubble phase are liquidated and their resources reallocated.

What about trucking? Well, trucking feeds the housing industry its materials and some of its manpower, so trucking shares this dual forecasting status. Sometimes it will be a leading indicator, sometimes a lagging one. Moreover, trucking feeds other industries as well, so it simply cannot be pigeonholed by a simplistic taxonomy. A sophisticated approach to business cycles requires us to abandon our primitive definitions of economic indicators. First, we must classify industries and sectors according to their status in the production and consumption hierarchy. Second, we must recognize the difference between recession and recovery.

We have still not exhausted the reserves of analysis, since there is still the possibility of inherent cyclical movements in economic activity that are not driven by monetary mistakes made by the authorities. The fact that money substitutes for barter in allowing human beings to trade the product of their labors solves huge problems, but it also creates smaller ones. These subtle problems may well mean that we have to live with an unavoidable element of cyclical instability in our economic life. And this may demand still more adjustments in the terminology of forecasting.

Progress Report on the DRI

The DRI is completing its fourth year of operation. It has passed the standard tests of stability, reliability and usefulness that apply to economic indices. Of course, it has not unlocked the door to wealth and fame available to any economic index that could actually forecast the future – but, as we have seen, that is a chimera. Explaining the past and recognizing the present is tough enough and a worthy goal for any economic index. Many a worthwhile aspirant has fallen short of even this limited objective; Ceridian’s PCI may be the latest addition to this list.

Nearly four years in, the DRI is still trucking.